No cash for Fairfax if media merger allowed: FNZC

NZME should no longer pay Fairfax Media $55 million as part of the proposed merger between the two news publishing groups if the courts clear the way for the union to go ahead, says broking firm First NZ Capital.

Announced in September last year, the deal to merge the New Zealand assets of Fairfax with NZME was rejected by the competition regulator, the Commerce Commission, in a decision in May. That decision was challenged in the High Court last month, with a judgment anticipated in the next two-to-three months.

"If the ComCom's decision is overturned then we advocate quite strongly for a review of merger terms, including non-price terms," said the head of institutional research at FNZC, Arie Dekker, in a note initiating coverage of the Auckland-based publisher of the New Zealand Herald and owner of radio stations accounting for abound 40 percent of the commercial market.

"With Fairfax NZ's lack of diversity (no radio) its terminal valuation calculation is in our view more challenging than that of NZME, which has the critical mass of radio to help support an online-only news and entertainment business". Dekker describes this as "quite a material advantage" when print advertising and subscriptions are declining for traditional newspaper publishers. The report assumes print editions of NZME's publications will close completely in around a decade.

The original merger terms propose NZME paying ASX-listed Fairfax $55 million to become a 41 percent shareholder in the merged entity, but NZME had performed better than Fairfax NZ since the merger was announced, leading to a re-rating for the NZME share price, the FNZC note said.

"There is, in our view, reason to reconsider merger pricing. We think NZME is arguably in a stronger position to navigate change and that its business, including its print business, should arguably be valued more highly than Fairfax NZ," Dekker said, noting that combining with Fairfax NZ will make the merged business more dominant in the declining print market.

Fairfax NZ also faced limited risk of the merger failing if it was paid up-front. FNZC suggested escrow arrangements should be put in place for a period to allow the anticipated synergies to emerge.

"With no escrow arrangements, Fairfax Media is not exposed to execution risk."

FNZC advocates a "no cash; equity only consideration for Fairfax NZ", with both NZME or the merged entity preferably focusing on debt reduction in an environment where Dekker sees NZME shrinking but remaining profitable on a standalone basis, but with operating earnings of around half current levels by 2030.

FNZC also questioned ongoing fixed cost lease obligations attaching to Fairfax NZ, which had a face value of $50 million in the 2016 accounts.

Even assuming NZME succeeded in cutting its costs, improving returns from radio and developing new sources of online revenue, Dekker still questioned "whether the news will be able to be supported in the future" on reduced sector revenues and where new online businesses could operate separately without a news component.

"Likely the breadth of coverage in such an environment will become narrower and more focused on what an audience is willing to pay for. It may not be possible to capture so many editorial views also. Interestingly, these are the reasons the ComCom turned down the NZME-Fairfax NZ merger."

Nonetheless, FNZC takes a cautiously positive view of NZME's potential, rating the stock 'neutral' and targeting a share price of 88 cents "if NZME can manage its current transition" and "de-risks the business through debt repayment" at the expense of lower dividends.

NZME shares were trading this afternoon at 92 cents per share and have risen 52.5 percent over the course of this year.

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